The beginner's guide to saving for retirement

When I was 22, a friend’s aunt—a wise woman and a CPA—gave me some great advice: “Contribute to your retirement account at work. Doesn’t matter if it’s just $50 a month. Just do it. Okay?”

I nodded dutifully. I didn’t have a job yet. I hadn’t even graduated from college yet, and was far more worried about finding a job at all than about preparing for a distant time when I wouldn’t work anymore.

Months later, when I started my new job, I remembered her advice, and so I put $50—maybe it was even $100—a month into my company’s 403(b). When it came time to decide where I wanted to put it, I remembered that people always said investments should be diversified. So I put a third of my money into a Fidelity account, a third of it into a Vanguard account, and a third of it into TIAA-CREF.

I thought that was diversifying.

I had a lot to learn.

But saving for retirement doesn’t have to be that hard, and it shouldn’t cause undue anxiety.

Remember: The worst thing you can do is do nothing.

Despite all the talk about diversification and fees, the most important step in your retirement planning is simply getting started. It’s never too early to start, and the earlier you start, the less you’ll have to save to meet your retirement goals. If you’re reading this, you’re already way ahead of most people.

Example: If a 22-year-old (much like I was) making $40,000 a year puts away 10% of her income (plus a 3% employer match, about the average) each year, then she’d have a tidy little nest egg of $1.7 million by the time she turns 65. And that’s not taking into account raises or increases in contributions. That’s if that 22-year-old kept contributing that same, flat amount for the next 43 years. However, if she waits until she’s 32 to start contributing, that same strategy is only going to net her $780,000, which is nothing to sneeze at, but a far cry from $1.7 million.

The best time to start is right now

Compound interest is an amazing thing. It’s when the interest you’ve earned starts earning interest itself and then that new interest eventually also starts earning interest and well, you see where I’m going with this. Your money makes money for you. It’s so amazing that people attributed a fake quotation about it to Albert Einstein.

Don’t get confused by all the acronyms and weird letter-number combos.

401(k)s and 403(b)s

A 401(k) is just an account you get through your employer and which is funded through pre-tax payroll deductions. A 403(b) is an account you get if your employer is an educational institution or a non-profit.

IRAs

IRA stands for Individual Retirement Account, and is an account that’s not dependent on where you work; anyone can open one. IRAs are ideal for someone who doesn’t have an employer or whose employer does not offer a 401(k) (which is about half of America’s workforce). But many people save in an IRA and a 401(k) or 403(b) simply because IRAs offer some benefits that employer-sponsored retirement accounts don’t. IRAs come in different varieties: the Roth IRA, which uses after-tax money, the traditional IRA, which is tax-deductible, and the SEP IRA, which is for the self-employed (and is also tax-advantaged).

All these accounts have slightly different features and rules. But all of them are merely vehicles for your money, a way to get it from point A (now) to point B (later, when you need to retire with a big cushion of cash).

Social Security will be around, but you shouldn’t count on it

What about Social Security, you ask? You may have heard about it (it’s a political topic that never goes away), and noticed payroll taxes that are taken out of your check. Social Security is spoken about as though it’s constantly imperiled, but things are not quite that dire. That said, Social Security benefits will not be enough to secure a comfortable retirement, either at their current levels or at the reduced levels likely by the time people currently in their 20s or 30s are set to retire (absent any action on the part of the government to make up for the coming shortage). (For a more thorough explanation of the state of Social Security, see this fact sheet from the Pew Research Center.)

Social Security will likely be available in some form, but it’s hard to say exactly what form that will be. It’s exceptionally popular with both Republican and Democratic voters, so cutting it is verrrrrry unlikely, but Republican lawmakers hate it, so increasing its funding is going to be hard. As such, it’s best to keep it out of your retirement planning altogether. Think of it the way you would a potential inheritance—as something nice to have, but not absolutely essential.

Uncle Sam might not be much help with your retirement, but your employer can be

• If your employer offers a match, make sure you contribute enough to get the maximum match available.
• The average match is up to half of 6% of your pre-tax income, but check with your company’s HR department to find out your company’s policy. Make sure you hit that 6%, so you can be putting away 9% of your total income each year.
• Employer match is part of your overall compensation package, so not taking advantage of it is like throwing away a check instead of cashing it. Your employer certainly factors the cost of retirement benefits (as well as health insurance, taxes, and other stuff) into your salary offer, so you should feel no compunction about taking that money.

Putting away enough to get the maximum match is pretty much the minimum you should save. Ideally, you’d save much more, and the 3% match from your company will act as a nice little boost. A good way to keep increasing your retirement savings is to automatically increase your 401(k) contributions every time you get a raise. You won’t miss it if you never get used to having it.

If your employer doesn’t offer a match, then you might be better off skipping the 401(k) altogether and opening a Roth IRA. A Roth IRA is possibly the best way young people can save for retirement.

• A Roth IRA is funded with after-tax money, which means that 40 years from now when you start taking withdrawals, you won’t have to pay taxes on it. (This isn’t the case for 401(k)s or traditional IRAs.)
• The most you can contribute to an IRA in 2017 and 2018 is $5,500. Additional limitations apply if you’re a high earner.
• You have up until tax day (April 15th) to make IRA contributions that will count for the previous year.
• If you max out your Roth IRA, but still have some money left over you want to save for retirement, you should put it into the 401(k), which has a yearly limit of $18,500. (Obviously, this is only if your employer does not offer a match.)

If you wanted to be a retirement savings superstar, then you’d aim to max out both your 401(k) and your Roth IRA. But that’s $23,500 a year, and most people don’t just have that lying around.

Once you’ve started saving, make sure you’re putting that money to work—in stocks

If you’re in your 20s or 30s, then you’ve got a long way to go before you’re going to need your retirement savings. As such, you should have a very high tolerance for risk. Even if the market takes a dive (like, say, it did in 2008-2009), you’ll have plenty of time (possibly decades!) for the market to recover.

What if it never recovers, you ask? All I can say is that, should the global financial system collapse, we’ll all have bigger problems than our retirement accounts—like finding fresh water and shelter from the zombie hordes.

Thus, you should have most of your money in stocks, which carry the highest risk but also offer the greatest rewards. As you get older, into your 40s or 50s, you’ll want to move your money out of stocks and into safer assets, like bonds. But for now, you want to maximize your market exposure so you can maximize your returns.

Don’t pick stocks yourself

Picking individual stocks is most likely a loser’s game, as is paying a financial advisor to pick stocks for you. Research has shown that, over the long term, it’s very rare for an investor to beat the market. They may beat it for a year or two, but it rarely lasts over the long term.

Instead of trying to pick individual winners, you should consider investing your money is low-cost index funds or ETFs. These are financial products that track a broader market (whether the overall market, or smaller segments like the S&P 500, or US bonds), and are a good way to get significant exposure to the stock market at a minimal cost. A diverse portfolio is one that is spread out across many different asset classes. For a young person, this might mean investing in lots of different kinds of stocks—small cap, mid-cap, large-cap, international, domestic—so that if there’s a slump in one sector, it’ll be offset by a gain in another. It’s a way to insulate yourself against serious loss.

Most brokerage firms offer several index funds to choose from, and, if that’s too complicated, target-date funds, which automatically rebalance as you get older to reflect a more conservative risk profile. These funds, unlike actively managed mutual funds, also have low fees, so you’ll get to keep more of your returns.

Read more: Target-date funds vs index funds

There are now automatically managed investment accounts (AMIAs, as we call them around here, or “robo-advisors” for the vulgar) that take the work of diversifying out of your hands, by having a computer do it.

Betterment is a great example

Betterment is a robo-advisor that automates your investments, but they also help you plan for retirement. Their service, Retirement Goals, can help you manage your retirement accounts. You can see your full retirement balance, including external accounts. For example, you can link your company 401(k) to your Retirement Goal and see your full, aggregated balance. Retirement Goals also gives advice on how much you really need to save for retirement each year, plus how to allocate that money across employee-sponsored plans, IRAs, and taxable accounts.

Betterment can show you when you’re paying too much in fees for your investments, but they’ll also alert you of any external allocations that are out of line with their advice. If you’re still not swayed, they’ll show you a rollover preview to demonstrate how your money will look at Betterment if you choose to make the switch.

Read more: Best Robo-advisors

Once you’re saving automatically, leave the account (mostly) alone

Once you’ve got your payroll deductions or automatic transfers set up, and once you’ve managed to select a range of diverse index funds or ETFs, the best thing you can do is leave it alone. Check-in once or twice a year, to see if fluctuations in the market have thrown your asset allocation out of wack. (Say, if, mid-cap stocks, which should be only 20% of your portfolio, are now closer to 25% or 30% of it.)

Otherwise, let it be. Paying too much attention to the day-to-day ups and downs of the stock market is a recipe for anxiety. Worse, a particularly bad day might convince you to pull your money out of stocks altogether, and then you’ll miss out on the inevitable rebound.

A report by JP Morgan Asset Management showed that, by just missing out on the ten best trading days during a 20-year period, an investor could see their annual returns halved. And many of those best days will inevitably come after a significant decline. Timing the market is impossible, so a buy-and-hold method is best.

Do not cash out your 401(k) or IRA before you’re ready to retire

It can be tempting if you’ve got money troubles, or really want something, to think of cashing out your retirement fund. But don’t! If you do so before the age of 59 ½, you’ll face steep penalties (10%!) and, in the case of 401(k)s and traditional IRAs, income taxes.

Beyond that, that money you take out (and the money you pay to the IRS for taking it out early) will no longer be earning interest, and then that interest won’t be earning its own interest, and, well, the whole compound interest thing will just not work out nearly as well.

To quote former Vice President Al Gore (for you younger folks, he’s the An Inconvenient Truth guy), what you want to do is take that money, and put it in a lockbox. They’ll be a lot more of it when you check again in 40 years.

Read more:

• 23 things beginners must know about saving for retirement
• Compare the best stock brokers and investment accounts for young investors
• How Much should be in your 401(k) at thirty?
• How much should you contribute to your 401(k)?